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Indian Banking Sector Expected to Recover with Credit Growth Rising to 12-13% by FY26

The Indian banking sector appears to be on track for a recovery after a slowdown in credit growth over the past year. According to the latest industry estimates, credit growth, which dropped from 16% in May 2024 to around 10% currently Aug 2025, is projected to rebound to 12-13% by the end of FY26. This recovery will be driven mainly by Non-Banking Financial Companies (NBFCs) and mortgage lending supported by falling interest rates.

Credit Growth Trends and Outlook

After a period of strong growth in FY24, the banking sector experienced a slowdown due to tighter liquidity conditions and a series of rate cuts by the Reserve Bank of India (RBI). As a result, net interest margins (NIMs) came under pressure. However, with interest rates declining and demand for retail and housing loans picking up, analysts expect a steady rebound in lending activity.

Key Drivers of Credit Growth

  • NBFC-led expansion: Non-Banking Financial Companies are increasing their lending activities in retail and small business segments.
  • Mortgage demand: Lower home loan rates are expected to boost housing demand and mortgage lending.
  • Falling interest rates: The 100-basis-point rate cuts implemented by RBI have made borrowing cheaper for consumers and businesses.

Impact on Margins and Profitability

Net interest margins have been under pressure due to the recent 100 basis points of rate cuts. Analysts expect margins to bottom out in Q2 or Q3 before improving sequentially as credit demand strengthens. Banks will need to manage costs and maintain asset quality to protect profitability during this transition.

Public Sector vs Private Sector Banks

Public Sector Banks (PSBs) have been aggressively gaining market share by offering higher interest rates on term deposits — about 30-40 basis points more than private banks — and lower mortgage rates. While this strategy is attracting customers, it may also impact their profitability in the near term.

On the other hand, Private Sector Banks are considered safer investments due to stronger balance sheets, better risk management, and more stable net interest margins.

Comparison at a Glance

  • Public Sector Banks: Aggressive pricing, higher deposit rates, lower mortgage rates, higher market share but possible profitability pressure.
  • Private Sector Banks: Stronger balance sheets, better margin protection, safer investment option for investors.

Valuations and Investment Outlook

Currently, banking sector valuations are cheaper compared to the broader market, which makes the sector attractive for medium to long-term investors. Analysts expect the recovery to begin in the third or fourth quarter as credit growth picks up and margins stabilize.

Key Takeaways for Investors

  • Credit growth projected to rise to 12-13% by FY26.
  • NBFCs and mortgage loans to drive the recovery.
  • Margins expected to bottom out in Q2 or Q3, with gradual improvement thereafter.
  • Private sector banks may offer safer opportunities due to stronger financials.
  • Valuations are attractive compared to broader markets, offering potential upside.

Conclusion

The Indian banking sector is entering a transitional phase where falling interest rates and rising credit demand could revive growth. Investors and stakeholders should watch for improvements in net interest margins and asset quality in the upcoming quarters. With supportive conditions, the sector may deliver double-digit credit growth by the end of FY26, creating opportunities for both banks and investors.

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